by Merriman
On top of that, we still have the downside of the Jupiter transit through the signs ahead of us for the next three years. As noted before, Jupiter in Aries was the basis for the “Asset Inflation Express” we went through from mid-2010 through early June 2011. Historically this coincides with a top in U.S. stocks when Jupiter is between 23° Aries and 7° of Taurus, a condition that was present May 2-July 22. If you look at a chart of the Dow Jones Industrial Average, you will see the market topped out May 2 at 12,876, with a triple top on July7 and 21 at 12,754 and 12,751 respectively. The top was not in the middle, but in the beginning and end of that sector. Then it dropped 1600+ points from July 21 into this week. The “Asset Inflation Express” had derailed as Jupiter moved into Taurus in the first week of June. But then after posting a double bottom June 15 and 23, it appeared to have righted itself into July 21. But not so. It really derailed again these past two weeks.
Now we wait to see what happens when Jupiter retrogrades back to 0° Taurus later this year. In fact it is back between 0-7° of Taurus from October 7, 2011 through March 7, 2012. Will it make a new high then? A secondary high? I don’t know the answer to that yet, but the study of Financial Astrology allows for the possibility. So far this market plunge is just a “normal” corrective decline for the 15.5-month cycle in U.S. stocks, and we are in the time frame when that cycle low is due (July 2011 through February 2012). But if we start breaking the critical support area of a normal corrective decline into the 15.5-month cycle trough, it will mean the 4-year cycle has topped out, and the bear market suggested by Jupiter’s transit into 2013-2014 is well underway.
How far could the DJIA fall in that case? Well, unlike most 72- and 90-year cycles, this one has not fallen 77-93% off its all-time highs yet. The decline from October 2007 through early March 2009 was only 54%. So, to a cycle’s analyst and a student of the history of Financial Astrology, the economic danger that was felt this week (as Uranus and Pluto came within just one degree of their exact square) is very real. We are on a path of financial self-destruction unless our economic direction changes. That’s the frightening message of Uranus square Pluto, 2012-2015, which will form a grand square to the USA natal Sun-Saturn square (2013-2014). The positive message is that it will change. But will it change before, during, or after 2012-2015? If after, it will change only because there are no choices left.
What we are all going through in 2008-2015 is not just an economic crisis brought on by well-intentioned but disastrous political and economic decisions, but an evolutionary crisis. The evolution of humanity is a never-ending quest to connect with one other, not to be destroyed by one another because we refuse to connect and wish only to control and force others to follow our ideological but disconnected agenda.
Tuesday, August 16, 2011
Monday, August 15, 2011
The coming bear markets in stocks
Unlike bull markets, which require time for investors to climb walls of worry on each up-leg, bear markets typically play out faster to the downside. The bear market of 2010-2011 should be no different. We feel this way for the following ten reasons.
The underlying thesis for our bearishness is quite simple: with debt issues metastasizing in Europe, discontent with Washington’s ineffectiveness growing by the day, and consumer confidence plunging to 30-year lows, the valuations that investors are willing to place on risky assets, i.e. stocks, have moved lower. While certainly the cheapest in years, the market’s current P/E of 12 is not cheap enough to mark an ultimate bear market bottom. Eventually the market’s P/E will trend down into the single digits just as they do at the end of every secular bear market for equities. This process will require a few years, resulting in many fits and starts as investors fight this trend.
While it is true that we are oversold and extended to the downside (the S&P 500 could very easily bounce back above 1,200 and move toward 1,225-1,250 in the next few weeks), this bounce will fail. Even with the recent slide in stocks, professional investor sentiment remains overly bullish. Doug Kass, Laszlo Birinyi, and Abby Joseph Cohen (check out her revised 1,400 year-end target for the S&P 500 in this weekend’s edition of Barrons!) remain ardent bulls. With these pros and others buying into the “current correction”, in time, these investors will help fuel another down-leg when they change their bullish tune and recognize that they are wrong.
This is a global bear market. Brazil, China, and the European bourses are leading the U.S. lower. We expect this trend to continue. In the very near-term, Europe’s markets rallied after short-selling was banned in a number of countries. When the buying dries up and with no shorts to provide buying power on the way down, we feel that this removal of the shorts will backfire for Europe just as it did in the U.S. a few years ago. Here is what Jim Chanos had to say on this matter late last week: “EU policy makers don’t seem to understand the law of unintended consequences. The vast majority of short-selling financial shares is by other financial institutions, hedging their counterparty risks, not speculators. The interbank lending market froze up completely in October to December 2008 – after the short-selling bans.”
Do not expect a quick fix from Tuesday’s summit between Germany and France. This weekend, Germany rejected calls by Italian Finance Minister Tremonti for the creation of Euro-bonds which would effectively make individual governments’ debt a common burden. Germany’s Finance Minister Wolfgang Schaueble quickly rejected this plan in Der Spiegel: “I rule out euro bonds for as long as member states conduct their own financial policies, and we need differing interest rates so that there are possibilities of incentive and sanctions to force fiscal solidity.” Ultimately, Germany will have to make a choice to either backstop Italy and Spain or let them default on their debt. With many in Merkel’s inner circle recommending that she steer away from eventually rescuing Italy because such actions could put Germany’s own banking system in peril, we feel that Germany will ultimately let Italy go. Perhaps this is why interbank lending has begun to materially slow down in Europe and why Bridgewater Associates released the following short note on Thursday: “There is an uncomfortably high probability that there will be an unmanaged banking and sovereign-debt crisis in Europe.”
Listen to Bert Dohmen, the editor of The Wellington Letter. Bert has had a tremendous track record of forecasting recessions and bear markets. According to Bert, we entered a recession in May and profit forecasts for the second half of this year are too high and will be revised lower. In a recent interview on CNBC, Bert gave his market thoughts.
If one noted technician’s bearish call was not enough, take note of another’s: Stan Weinstein, who many consider one of the all-time greats of technical analysis, gave a bear market alert to his subscribers when all of the major indexes broke below their 200-day Simple Moving Averages in early August. According to Stan, there has been inordinate damage done to the market’s underlying technical structure. Having just moved into what Stan labels as stage 4, or the declining phase, this bear market has just begun and will need time to run its course.
China’s economy is slowing down rapidly. At some point, investors will turn their attention here. When they do, they will not like what they see. Just look at some recent stats on China’s economy: China’s bank lending slowed down rather sharply in July to a 7-month low; China’s money supply growth recently fell to a 6-year low; China’s July auto sales were extremely weak. While they rose 6.7 percent in July, the rise was well below expectations and the growth seen last year. Could these economic numbers explain why Brazil’s stock market is one of the worst in the world this year and why the materials ETF, Materials Select Sector SPDR ETF (XLB), plunged 16% from its early August highs?
Small-caps are leading the way lower in the U.S. While so many market pundits continue to try to buy the dip and call a bottom for stocks in various interviews the past 72 hours, not one of them has made mention of how small-caps have already moved into bear-market territory. Just as small-caps lead the bull market on the way up, they are leading on the way down. This is a very bearish sign.
The consumer is about to retrench in a meaningful way. Those bullish surely looked at July’s retail sales as a cause for celebration. However, these shoppers were gleefully shopping before their stock accounts plunged this month. Perhaps we should therefore give more attention to Friday’s plunge in consumer confidence to 30-year lows! With the consumer 70% of our economy, a move upwards in the savings rate to 7-8% will ultimately translate into much slower growth for the economy. Slower growth means lowered earnings expectations for Q3 and Q4 and for 2012. Lowered numbers leads to lower valuations and ultimately to lower prices for stocks.
The individual investor is done with stocks. Ordinarily, this would be a positive contrarian sign. Considering that mutual funds remain fully invested and at historical lows for cash levels, however, the fact that individual investors pulled $11 billion from stock mutual funds last week is quite troubling.
This trend seems destined to accelerate in the coming months, forcing mutual fund managers to sell more stocks to meet the calls for cash from their investors. Considering that tax-selling is just around the corner for professional and individual investors, this dearth of buying power will eventually force stock prices lower.
When we objectively take note of the aforementioned considerations, we remain quite bearish of stocks for at least the next 3-6 months. Because bear market rallies are sharp, vicious, and short-lived, we plan on patiently selling into this rally by going long the ProShares UltraShort Russell 2000 ETF (TWM), for the accounts we oversee. We remain buyers of the SPDR Gold Trust ETF (GLD) on pullbacks and have begun to slowly deploy money into select gold mining stocks with an eye toward their eventual break outs later this year/early next.
We also remain long two inflection point plays that most investors have never heard of before: Dynatronics (DYNT) and eGain Communicatiosn (EGAN.OB). With various catalysts approaching for both companies, including a potentially forthcoming lucrative and game-changing G.P.O. contract win for Dynatronics later this fall, we feel that both stocks will be much higher a year from now.
In conclusion, bear markets should not be feared as they will ultimately reward patient investors with bargain buys. Instead of being feared, bear markets should rather be respected. For us, that means understanding that now is the time for patience and discipline and not for aggressively buying into a bear market that is only three weeks old.
The underlying thesis for our bearishness is quite simple: with debt issues metastasizing in Europe, discontent with Washington’s ineffectiveness growing by the day, and consumer confidence plunging to 30-year lows, the valuations that investors are willing to place on risky assets, i.e. stocks, have moved lower. While certainly the cheapest in years, the market’s current P/E of 12 is not cheap enough to mark an ultimate bear market bottom. Eventually the market’s P/E will trend down into the single digits just as they do at the end of every secular bear market for equities. This process will require a few years, resulting in many fits and starts as investors fight this trend.
While it is true that we are oversold and extended to the downside (the S&P 500 could very easily bounce back above 1,200 and move toward 1,225-1,250 in the next few weeks), this bounce will fail. Even with the recent slide in stocks, professional investor sentiment remains overly bullish. Doug Kass, Laszlo Birinyi, and Abby Joseph Cohen (check out her revised 1,400 year-end target for the S&P 500 in this weekend’s edition of Barrons!) remain ardent bulls. With these pros and others buying into the “current correction”, in time, these investors will help fuel another down-leg when they change their bullish tune and recognize that they are wrong.
This is a global bear market. Brazil, China, and the European bourses are leading the U.S. lower. We expect this trend to continue. In the very near-term, Europe’s markets rallied after short-selling was banned in a number of countries. When the buying dries up and with no shorts to provide buying power on the way down, we feel that this removal of the shorts will backfire for Europe just as it did in the U.S. a few years ago. Here is what Jim Chanos had to say on this matter late last week: “EU policy makers don’t seem to understand the law of unintended consequences. The vast majority of short-selling financial shares is by other financial institutions, hedging their counterparty risks, not speculators. The interbank lending market froze up completely in October to December 2008 – after the short-selling bans.”
Do not expect a quick fix from Tuesday’s summit between Germany and France. This weekend, Germany rejected calls by Italian Finance Minister Tremonti for the creation of Euro-bonds which would effectively make individual governments’ debt a common burden. Germany’s Finance Minister Wolfgang Schaueble quickly rejected this plan in Der Spiegel: “I rule out euro bonds for as long as member states conduct their own financial policies, and we need differing interest rates so that there are possibilities of incentive and sanctions to force fiscal solidity.” Ultimately, Germany will have to make a choice to either backstop Italy and Spain or let them default on their debt. With many in Merkel’s inner circle recommending that she steer away from eventually rescuing Italy because such actions could put Germany’s own banking system in peril, we feel that Germany will ultimately let Italy go. Perhaps this is why interbank lending has begun to materially slow down in Europe and why Bridgewater Associates released the following short note on Thursday: “There is an uncomfortably high probability that there will be an unmanaged banking and sovereign-debt crisis in Europe.”
Listen to Bert Dohmen, the editor of The Wellington Letter. Bert has had a tremendous track record of forecasting recessions and bear markets. According to Bert, we entered a recession in May and profit forecasts for the second half of this year are too high and will be revised lower. In a recent interview on CNBC, Bert gave his market thoughts.
If one noted technician’s bearish call was not enough, take note of another’s: Stan Weinstein, who many consider one of the all-time greats of technical analysis, gave a bear market alert to his subscribers when all of the major indexes broke below their 200-day Simple Moving Averages in early August. According to Stan, there has been inordinate damage done to the market’s underlying technical structure. Having just moved into what Stan labels as stage 4, or the declining phase, this bear market has just begun and will need time to run its course.
China’s economy is slowing down rapidly. At some point, investors will turn their attention here. When they do, they will not like what they see. Just look at some recent stats on China’s economy: China’s bank lending slowed down rather sharply in July to a 7-month low; China’s money supply growth recently fell to a 6-year low; China’s July auto sales were extremely weak. While they rose 6.7 percent in July, the rise was well below expectations and the growth seen last year. Could these economic numbers explain why Brazil’s stock market is one of the worst in the world this year and why the materials ETF, Materials Select Sector SPDR ETF (XLB), plunged 16% from its early August highs?
Small-caps are leading the way lower in the U.S. While so many market pundits continue to try to buy the dip and call a bottom for stocks in various interviews the past 72 hours, not one of them has made mention of how small-caps have already moved into bear-market territory. Just as small-caps lead the bull market on the way up, they are leading on the way down. This is a very bearish sign.
The consumer is about to retrench in a meaningful way. Those bullish surely looked at July’s retail sales as a cause for celebration. However, these shoppers were gleefully shopping before their stock accounts plunged this month. Perhaps we should therefore give more attention to Friday’s plunge in consumer confidence to 30-year lows! With the consumer 70% of our economy, a move upwards in the savings rate to 7-8% will ultimately translate into much slower growth for the economy. Slower growth means lowered earnings expectations for Q3 and Q4 and for 2012. Lowered numbers leads to lower valuations and ultimately to lower prices for stocks.
The individual investor is done with stocks. Ordinarily, this would be a positive contrarian sign. Considering that mutual funds remain fully invested and at historical lows for cash levels, however, the fact that individual investors pulled $11 billion from stock mutual funds last week is quite troubling.
This trend seems destined to accelerate in the coming months, forcing mutual fund managers to sell more stocks to meet the calls for cash from their investors. Considering that tax-selling is just around the corner for professional and individual investors, this dearth of buying power will eventually force stock prices lower.
When we objectively take note of the aforementioned considerations, we remain quite bearish of stocks for at least the next 3-6 months. Because bear market rallies are sharp, vicious, and short-lived, we plan on patiently selling into this rally by going long the ProShares UltraShort Russell 2000 ETF (TWM), for the accounts we oversee. We remain buyers of the SPDR Gold Trust ETF (GLD) on pullbacks and have begun to slowly deploy money into select gold mining stocks with an eye toward their eventual break outs later this year/early next.
We also remain long two inflection point plays that most investors have never heard of before: Dynatronics (DYNT) and eGain Communicatiosn (EGAN.OB). With various catalysts approaching for both companies, including a potentially forthcoming lucrative and game-changing G.P.O. contract win for Dynatronics later this fall, we feel that both stocks will be much higher a year from now.
In conclusion, bear markets should not be feared as they will ultimately reward patient investors with bargain buys. Instead of being feared, bear markets should rather be respected. For us, that means understanding that now is the time for patience and discipline and not for aggressively buying into a bear market that is only three weeks old.
Monday, July 25, 2011
China economic slowdown - hard or soft?
This is written by Chris Woods.
Recessions are man-made. Or rather central bank induced. See the way BOJ applied the brakes to Japan's economy in 1989. So will the continued tightening by China's central bank lead to a mild recession (soft landing) or a prolonged slowdown (hard landing).
Analysts at Fitch who first drew attention to the fact that broad credit growth in China was much stronger last year than indicated by a focus on the narrow renminbi bank lending data. This argument was, importantly, confirmed earlier this year when the PBOC published its new “social financing” data series, which includes bank loans, entrusted loans, trust loans, bank acceptances, corporate bond issuance and non-financial sector equity financing. This indicated that, based on this broader credit measure, total credit growth was even greater in 2010 than in 2009, the year of the post-Lehman bust command-economy surge in bank lending to local governments' infrastructure projects. Thus, total social financing volume was Rmb14.27tn in 2010, compared with Rmb14.1tn in 2009.
What is interesting about this latest Fitch report is that the authors argue that broader credit has not slowed as much this year as suggested by both the bank lending and social financing data. In an attempt to measure better broader credit growth, Fitch has come up with its own so-called “adjusted total social financing (TSF)” index. This indicates four main areas that Fitch argues are not properly counted in the official social financing data; namely letters of credit, credit from domestic trust companies, credit extended by other non-bank financial institutions and credit extended from Hong Kong banks.
Thus, despite the ongoing credit tightening in China, as reflected in daily loan-deposit ratio targets on individual banks, Fitch estimates that, based on its adjusted TSF, total financing is expected to exceed Rmb18tn in 2011, or 38% of GDP. True, this rate of growth is down from the average of 42% of GDP in 2009 and 2010. But it is still well above the pre-2008 average growth in broader credit of 22% of GDP. It is also important to highlight that Fitch estimates that more than 55% of the new financing is expected to come from areas outside bank lending, since the formal banking system is clearly experiencing much tighter conditions as reflected in those daily loan-deposit ratio targets. If the Fitch methodology is correct, the overall credit to GDP is now becoming worryingly large both in terms of its absolute size and in terms of the scale of the ramp up in the past three years. Thus, Fitch estimates that the ratio of total stock of credit to GDP is on course to reach 185% of GDP by the end of this year, up from just 124% of GDP at the end of 2007. This sort of rapid ramp up in credit to GDP (up 61ppts) is often a prelude to an over investment-led banking crisis, as Fitch also highlights by quoting relative historical comparisons, be it Japan between 1985-1990 (credit/GDP up 45ppts), Korea from 1994-1999 (up 47ppts) or America and Britain from 2002-2007 (up 41ppts and 50ppts respectively).
All these mean a big flashing yellow light (though not a red yet) is the current signal for the China macro story. First, it means the authorities may have to stay tighter for longer to rein in the broader credit growth with the resulting damage that may do to economic activity. That a credit squeeze is already on is clear from the latest China Reality Research (CRR) survey of SMEs (SME Quarterly – Credit crunch bites, 15 July 2011). Thus, the share of SMEs finding it harder to access bank loans compared with a year ago soared to 74% in 2Q11 from 52% in 1Q11, with 80% of them facing higher financing costs in the quarter (see Figure 2). It is also clear from very high black market lending rates. Thus, the latest CRR monthly survey on China’s informal financing market reported that the annualised underground lending rate in Wenzhou, a centre of China’s informal lending business, rose to 66% in June, a new record high since this particular data series began in March 2006 (see Figure 3 and CRR research Banking – Underground lending, 4 July 2011). There is also the technical issue of whether the relevant authorities, such as the CBRC, have the means to rein in what could be termed China’s shadow banking system.
Still the China story is more nuanced than the China bears often take into account. This is because of the political and social context and the related command-economy banking system. This means China can take the credit-to-GDP ratio to higher levels than would be the case somewhere else. Still key “pillars” of the system need to remain in place; most particularly healthy deposit growth and continued control over the capital account. For now deposit growth remains healthy at 17.6%YoY. As for the capital account, the risk to watch out for is whether the offshore renminbi market creates leakages which cause a potential loss of control for the authorities. SO watch out for potential leakages as well as the authorities’ efforts to rein in broader credit growth need to be watched. Indeed the two are connected in a certain respect, as reflected in Hong Kong banks’ surge in claims on the mainland in recent years. Thus, Hong Kong banks’ total claims on the mainland have quadrupled over the past two years from HK$407bn in April 2009 to HK$1.8tn at the end of April 2011, according to the Hong Kong Monetary Authority
For now the mainland authorities appear to be relatively relaxed about all this because the prevailing concern has been “hot money” inflows into China. Hence, the decision at the end of last year to allow exporters to keep their overseas revenues offshore. Under the program, qualified Chinese exporters can hold up to five overseas accounts and are free to decide on the length of time they keep income offshore. Hence, also the continued relaxed official attitude to the ongoing boom in Macau. Thus, Macau gaming revenue was up 52.4%YoY in June.
Still all this could change in a heartbeat if there is sudden evidence of an outflow. In this respect it is also important to understand that China’s capital account has become increasingly porous in recent years, in the sense that it has been seemingly easy for the rich and connected to get their money out. This raises the issue of what is the concentration of ownership of household deposits. The data is not available. But the more concentrated the ownership the bigger the potential risk. On this point, household deposits account for 42% of total bank deposits in China. Clearly it would be a surprise if household deposits are not quite concentrated in China. On this point a clue to the concentration of wealth in China, and the growing trend of sending money offshore, was provided by a recent survey carried out by the consultancy firm Bain & Company and China Merchants Bank. They found that the investible wealth of Chinese individuals was Rmb62tn, and that the number of Chinese with more than Rmb10m in investible assets have nearly doubled since the onset of global recession in 2008 to 585,000 this year. The report also found that rich Chinese have doubled the share of their portfolios invested overseas from 10% in 2009 to 20% this year.
All of the above serve to alert investors to the obvious systemic risks that are the consequences of the mainland’s command economy structure. It is also the case that the higher the base in terms of the level of money supply or credit to GDP, the harder the challenge for the authorities both to maintain control and politically acceptable growth rates. In this respect the best analogue for the Chinese economy is the same as it was for the Japanese economy in the late 1980s. That is the bicycle economy. The question is how long the rider can stay on the bicycle. For now, it is safe to assumes that the rider can stay on the bicycle. But that is an assumption that will have to be stress tested regularly. The positive point is that the Chinese authorities are much more aware of the over-investment risk than the Japanese were in the late 1980s. Indeed the Japanese bureaucracy did not even understand there was such a risk. But the negative point is that the China system story is much more starkly binary in the sense that if the economy collapses so, likely, will also the political system.
Recessions are man-made. Or rather central bank induced. See the way BOJ applied the brakes to Japan's economy in 1989. So will the continued tightening by China's central bank lead to a mild recession (soft landing) or a prolonged slowdown (hard landing).
Analysts at Fitch who first drew attention to the fact that broad credit growth in China was much stronger last year than indicated by a focus on the narrow renminbi bank lending data. This argument was, importantly, confirmed earlier this year when the PBOC published its new “social financing” data series, which includes bank loans, entrusted loans, trust loans, bank acceptances, corporate bond issuance and non-financial sector equity financing. This indicated that, based on this broader credit measure, total credit growth was even greater in 2010 than in 2009, the year of the post-Lehman bust command-economy surge in bank lending to local governments' infrastructure projects. Thus, total social financing volume was Rmb14.27tn in 2010, compared with Rmb14.1tn in 2009.
What is interesting about this latest Fitch report is that the authors argue that broader credit has not slowed as much this year as suggested by both the bank lending and social financing data. In an attempt to measure better broader credit growth, Fitch has come up with its own so-called “adjusted total social financing (TSF)” index. This indicates four main areas that Fitch argues are not properly counted in the official social financing data; namely letters of credit, credit from domestic trust companies, credit extended by other non-bank financial institutions and credit extended from Hong Kong banks.
Thus, despite the ongoing credit tightening in China, as reflected in daily loan-deposit ratio targets on individual banks, Fitch estimates that, based on its adjusted TSF, total financing is expected to exceed Rmb18tn in 2011, or 38% of GDP. True, this rate of growth is down from the average of 42% of GDP in 2009 and 2010. But it is still well above the pre-2008 average growth in broader credit of 22% of GDP. It is also important to highlight that Fitch estimates that more than 55% of the new financing is expected to come from areas outside bank lending, since the formal banking system is clearly experiencing much tighter conditions as reflected in those daily loan-deposit ratio targets. If the Fitch methodology is correct, the overall credit to GDP is now becoming worryingly large both in terms of its absolute size and in terms of the scale of the ramp up in the past three years. Thus, Fitch estimates that the ratio of total stock of credit to GDP is on course to reach 185% of GDP by the end of this year, up from just 124% of GDP at the end of 2007. This sort of rapid ramp up in credit to GDP (up 61ppts) is often a prelude to an over investment-led banking crisis, as Fitch also highlights by quoting relative historical comparisons, be it Japan between 1985-1990 (credit/GDP up 45ppts), Korea from 1994-1999 (up 47ppts) or America and Britain from 2002-2007 (up 41ppts and 50ppts respectively).
All these mean a big flashing yellow light (though not a red yet) is the current signal for the China macro story. First, it means the authorities may have to stay tighter for longer to rein in the broader credit growth with the resulting damage that may do to economic activity. That a credit squeeze is already on is clear from the latest China Reality Research (CRR) survey of SMEs (SME Quarterly – Credit crunch bites, 15 July 2011). Thus, the share of SMEs finding it harder to access bank loans compared with a year ago soared to 74% in 2Q11 from 52% in 1Q11, with 80% of them facing higher financing costs in the quarter (see Figure 2). It is also clear from very high black market lending rates. Thus, the latest CRR monthly survey on China’s informal financing market reported that the annualised underground lending rate in Wenzhou, a centre of China’s informal lending business, rose to 66% in June, a new record high since this particular data series began in March 2006 (see Figure 3 and CRR research Banking – Underground lending, 4 July 2011). There is also the technical issue of whether the relevant authorities, such as the CBRC, have the means to rein in what could be termed China’s shadow banking system.
Still the China story is more nuanced than the China bears often take into account. This is because of the political and social context and the related command-economy banking system. This means China can take the credit-to-GDP ratio to higher levels than would be the case somewhere else. Still key “pillars” of the system need to remain in place; most particularly healthy deposit growth and continued control over the capital account. For now deposit growth remains healthy at 17.6%YoY. As for the capital account, the risk to watch out for is whether the offshore renminbi market creates leakages which cause a potential loss of control for the authorities. SO watch out for potential leakages as well as the authorities’ efforts to rein in broader credit growth need to be watched. Indeed the two are connected in a certain respect, as reflected in Hong Kong banks’ surge in claims on the mainland in recent years. Thus, Hong Kong banks’ total claims on the mainland have quadrupled over the past two years from HK$407bn in April 2009 to HK$1.8tn at the end of April 2011, according to the Hong Kong Monetary Authority
For now the mainland authorities appear to be relatively relaxed about all this because the prevailing concern has been “hot money” inflows into China. Hence, the decision at the end of last year to allow exporters to keep their overseas revenues offshore. Under the program, qualified Chinese exporters can hold up to five overseas accounts and are free to decide on the length of time they keep income offshore. Hence, also the continued relaxed official attitude to the ongoing boom in Macau. Thus, Macau gaming revenue was up 52.4%YoY in June.
Still all this could change in a heartbeat if there is sudden evidence of an outflow. In this respect it is also important to understand that China’s capital account has become increasingly porous in recent years, in the sense that it has been seemingly easy for the rich and connected to get their money out. This raises the issue of what is the concentration of ownership of household deposits. The data is not available. But the more concentrated the ownership the bigger the potential risk. On this point, household deposits account for 42% of total bank deposits in China. Clearly it would be a surprise if household deposits are not quite concentrated in China. On this point a clue to the concentration of wealth in China, and the growing trend of sending money offshore, was provided by a recent survey carried out by the consultancy firm Bain & Company and China Merchants Bank. They found that the investible wealth of Chinese individuals was Rmb62tn, and that the number of Chinese with more than Rmb10m in investible assets have nearly doubled since the onset of global recession in 2008 to 585,000 this year. The report also found that rich Chinese have doubled the share of their portfolios invested overseas from 10% in 2009 to 20% this year.
All of the above serve to alert investors to the obvious systemic risks that are the consequences of the mainland’s command economy structure. It is also the case that the higher the base in terms of the level of money supply or credit to GDP, the harder the challenge for the authorities both to maintain control and politically acceptable growth rates. In this respect the best analogue for the Chinese economy is the same as it was for the Japanese economy in the late 1980s. That is the bicycle economy. The question is how long the rider can stay on the bicycle. For now, it is safe to assumes that the rider can stay on the bicycle. But that is an assumption that will have to be stress tested regularly. The positive point is that the Chinese authorities are much more aware of the over-investment risk than the Japanese were in the late 1980s. Indeed the Japanese bureaucracy did not even understand there was such a risk. But the negative point is that the China system story is much more starkly binary in the sense that if the economy collapses so, likely, will also the political system.
The economics of cloud computing - the greatest innovation since electricity
Thanks to the thousands of miles of fiber-optic cable laid during the late 1990s, the speed of computer networks has finally caught up to the speed of computer processors.
Thanks to the virtual desktop they developed, the PC quickly replaced the mainframe as the center of corporate computing and began showing up in homes across America.
Before long, companies began building intraoffice networks so that their employees could run programs like Microsoft Word and Excel on their PCs, and also access programs, files, and printers from a central server.
This model was far from perfect.
Due to a lack of standards in computing hardware and software, competing products were rarely compatible -- making PC networks far more inefficient than their mainframe predecessors.
In fact, most servers ended up being used as single-purpose machines that ran a single software application or database.
And every time a company needed to add a new application, it was forced to expand its data centers, replace or reprogram old systems, and hire IT technicians to keep everything running.
As a result, global IT spending jumped from under $100 billion a year in the early 1970s to over $1 trillion a year by the turn of the century.
IT-consulting firm IDC reports that every dollar a company spends on a Microsoft product results in an additional $8 of IT expenses.
And one IT expert admits, "Trillions of dollars that companies have invested into information technology have gone to waste."
Yet, companies have had no choice but to run these obscenely expensive and highly inefficient networks.
But that's all about to change...
And that's precisely why the two words "cloud computing" scare the hell out of Bill Gates.
You see, he realizes that thanks to the thousands of miles of fiber-optic cable laid during the late 1990s, the speed of computer networks has finally caught up to the speed of computer processors.
As IT expert Nicholas Carr explains, "What the fiber-optic Internet does for computing is exactly what the alternating-current network did for electricity."
Suddenly, computers that were once incompatible and isolated are now linked in a giant network, or "cloud."
As a result, computing is fast becoming a utility in much the same way that electricity did...
Think back a few years -- any time you wanted to type a letter, create a spreadsheet, edit a photo, or play a game, you had to go to the store, buy the software, and install it on your computer.
But nowadays, if you want to look at pictures on Facebook... find directions on MapQuest... watch a video on YouTube... or sell furniture on Craigslist... all you really need is an Internet connection.
Because although these activities require you to use your PC, none of the content you are accessing or the applications you are running are actually stored on your computer -- instead they're stored at a giant data center somewhere in the "cloud."
The Economist claims, "As computing moves online, the sources of power and money will increasingly be enormous 'computing clouds.'"
David Hamilton of the Financial Post says this technology "has the potential to shower billions in revenues on companies that embrace it."
And Nicholas Carr, former executive editor of the Harvard Business Review, has even written an entire book on the subject, titled The Big Switch. In it, he asserts: "The PC age is giving way to a new era: the utility age."
He goes on to make this prediction: "Rendered obsolete, the traditional PC is replaced by a simple terminal -- a "thin client" that's little more than a monitor hooked up to the Internet."
While that may sound far-fetched, in the corporate market, sales of these "thin clients" have been growing at over 20% per year -- far outpacing that of PCs.
According to market-research firm IDC, the U.S. is now home to more than 7,000 data centers just like the one constructed on the banks of the Columbia River in 2005.
And the number of servers operating within these massive data centers is expected to grow to nearly 16 million by the end of 2010 -- that's three times as many as a decade ago
Thanks to the virtual desktop they developed, the PC quickly replaced the mainframe as the center of corporate computing and began showing up in homes across America.
Before long, companies began building intraoffice networks so that their employees could run programs like Microsoft Word and Excel on their PCs, and also access programs, files, and printers from a central server.
This model was far from perfect.
Due to a lack of standards in computing hardware and software, competing products were rarely compatible -- making PC networks far more inefficient than their mainframe predecessors.
In fact, most servers ended up being used as single-purpose machines that ran a single software application or database.
And every time a company needed to add a new application, it was forced to expand its data centers, replace or reprogram old systems, and hire IT technicians to keep everything running.
As a result, global IT spending jumped from under $100 billion a year in the early 1970s to over $1 trillion a year by the turn of the century.
IT-consulting firm IDC reports that every dollar a company spends on a Microsoft product results in an additional $8 of IT expenses.
And one IT expert admits, "Trillions of dollars that companies have invested into information technology have gone to waste."
Yet, companies have had no choice but to run these obscenely expensive and highly inefficient networks.
But that's all about to change...
And that's precisely why the two words "cloud computing" scare the hell out of Bill Gates.
You see, he realizes that thanks to the thousands of miles of fiber-optic cable laid during the late 1990s, the speed of computer networks has finally caught up to the speed of computer processors.
As IT expert Nicholas Carr explains, "What the fiber-optic Internet does for computing is exactly what the alternating-current network did for electricity."
Suddenly, computers that were once incompatible and isolated are now linked in a giant network, or "cloud."
As a result, computing is fast becoming a utility in much the same way that electricity did...
Think back a few years -- any time you wanted to type a letter, create a spreadsheet, edit a photo, or play a game, you had to go to the store, buy the software, and install it on your computer.
But nowadays, if you want to look at pictures on Facebook... find directions on MapQuest... watch a video on YouTube... or sell furniture on Craigslist... all you really need is an Internet connection.
Because although these activities require you to use your PC, none of the content you are accessing or the applications you are running are actually stored on your computer -- instead they're stored at a giant data center somewhere in the "cloud."
The Economist claims, "As computing moves online, the sources of power and money will increasingly be enormous 'computing clouds.'"
David Hamilton of the Financial Post says this technology "has the potential to shower billions in revenues on companies that embrace it."
And Nicholas Carr, former executive editor of the Harvard Business Review, has even written an entire book on the subject, titled The Big Switch. In it, he asserts: "The PC age is giving way to a new era: the utility age."
He goes on to make this prediction: "Rendered obsolete, the traditional PC is replaced by a simple terminal -- a "thin client" that's little more than a monitor hooked up to the Internet."
While that may sound far-fetched, in the corporate market, sales of these "thin clients" have been growing at over 20% per year -- far outpacing that of PCs.
According to market-research firm IDC, the U.S. is now home to more than 7,000 data centers just like the one constructed on the banks of the Columbia River in 2005.
And the number of servers operating within these massive data centers is expected to grow to nearly 16 million by the end of 2010 -- that's three times as many as a decade ago
Wednesday, April 28, 2010
Why O'bama is the world's worst enemy
Never mind about the so-called terro ris ts. Or many of the world's other problems such as the environment. There is far worst than the world has ever seen. We are staring into the 'eye of the storm'. A perform storm of hyper-inflation. Why?
Because there is not enough accumulated savings in the known universe to satisfy the spending aspirations of Washington’s politicians. Why do they need to spend so much money I got no idea. To make America safe by creating war elsewhere? And to spend so much money that there is not enough for their basic education?
Below is an article from the Canada’s Globe & Mail:
“The money supply in the United States is doing something that almost never happens: it’s shrinking, after taking into account inflation. Similar episodes in the past have usually been scary times for investors. Declines in the amount of money in circulation have coincided with recessions, and some analysts looking at the current trend say it is a harbinger of trouble. Despite signs that the U.S. is in recovery, they worry that the money supply numbers indicate the economy remains vulnerable to the feared double-dip downturn, or is close to experiencing deflation.”
I agree with the first half of this proposition about a renewed economic downturn, but not the second. In fact, rather than deflation, the dollar is moving ever closer to hyperinflation.
How is deflation possible when crude oil prices have more than doubled since their post-Lehman crash low? Or more broadly, how can there be deflation when the price index of 19 commodities compiled by the Commodity Research Bureau rose 47% during this same period? It cannot of course, which means there is no deflation.
The ongoing decline in the purchasing power of the dollar has been masked by wealth destruction as over-priced assets like houses fall back to realistic levels. There is also the problem that the mainstream media broadcasts only the government calculated CPI, which is an inaccurate measure of the dollar’s eroding purchasing power.
As John Williams of www.shadowstats.com notes: “Over the decades, the BLS [Bureau of Labor Statistics] has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept.” John reports that his “SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to about 9.5%” in March from a year ago.
So the Globe & Mail article is wrong about deflation, but I am not drawing attention to it just because I agree that “the economy remains vulnerable to the feared double-dip downturn”. Instead, this article unintentionally offers compelling evidence that the dollar is approaching hyperinflation.
The so-called “shrinking” money supply that arises when adjusting for the loss of purchasing power from inflation is a characteristic portending imminent hyperinflation. Let’s call it a ‘Havenstein moment’, named after the ill-fated president of the Reichsbank who presided over the destructive hyperinflation that devastated Weimar Germany.
I first explained this phenomenon in September 2007 and questioned then whether the dollar would eventually hyperinflate because Ben Bernanke would follow the footsteps of Herr Havenstein. I quoted an insightful section from Murray Rothbard’s excellent book, The Mystery of Banking, that explicitly explains the consequences of the inflation-adjusted money supply. Here is the relevant part of that quote:
“When prices are going up faster than the money supply, the people begin to experience a severe shortage of money, for they now face a shortage of cash balances relative to the much higher price levels. Total cash balances are no longer sufficient to carry transactions at the higher price.”
As the Globe & Mail observes, these circumstances prevail today. Prices of goods and services are rising, but as it warns, the quantity of dollars in circulation is “shrinking, after taking into account inflation.” This “shortage of money” is being widely misinterpreted as deflation, which is exactly what happened in Weimar Germany shortly before the Reichsmark was swooped up in its hyperinflationary whirlwind.
Rothbard provides his usual brilliant insight to explain what happens once the “Havenstein moment’ is reached. There are two alternatives.
“If the government tightens its own belt and stops printing (or otherwise creating) new money, then inflationary expectations will eventually be reversed, and prices will fall once more – thus relieving the money shortage by lowering prices. But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to ‘catch up’ to prices, then the country is off to the races. Money and prices will follow each other upward in an ever-accelerating spiral, until finally prices ‘run away’…[i.e., hyperinflate]”
Weimar Germany took the second alternative.
The dollar has now reached its ‘Havenstein moment’. Will policymakers follow the prudent advice of Murray Rothbard and ‘tighten its belt’? Or like Herr Havenstein, will Mr. Bernanke continue to ‘print’?
No need to ponder these two alternatives. The Federal Reserve must ‘print’, for one reason. Despite the noble goals assigned to it in textbooks and offered in Congressional hearings, the Federal Reserve exists for only one reason – to make sure the federal government gets all the dollars it wants to spend, which consequently has put the dollar on a hyperinflationary course.
Spending by the federal government is out of control, causing it to borrow record amounts. The money to fund this growing mountain of debt must come from savings or ‘printing’, and the sad fact is that there is not enough accumulated savings in the known universe to satisfy the spending aspirations of Washington’s politicians. So beyond what it can collect from taxpayers and extract from the world’s savings pool, the dollars the federal government is spending can only come from one place – the ‘printing press’, which in the prevailing monetary system means bookkeeping entries of the Federal Reserve.
This process of creating new dollars ‘out of thin air’ creates the hyperinflation, which the ‘Havenstein moment’ indicates is near. Sadly, like Weimar Germany, few people are prepared for this impending destruction of the dollar, but the remedy is simple – as much as practical, avoid the dollar. Own physical gold and physical silver instead.
Because there is not enough accumulated savings in the known universe to satisfy the spending aspirations of Washington’s politicians. Why do they need to spend so much money I got no idea. To make America safe by creating war elsewhere? And to spend so much money that there is not enough for their basic education?
Below is an article from the Canada’s Globe & Mail:
“The money supply in the United States is doing something that almost never happens: it’s shrinking, after taking into account inflation. Similar episodes in the past have usually been scary times for investors. Declines in the amount of money in circulation have coincided with recessions, and some analysts looking at the current trend say it is a harbinger of trouble. Despite signs that the U.S. is in recovery, they worry that the money supply numbers indicate the economy remains vulnerable to the feared double-dip downturn, or is close to experiencing deflation.”
I agree with the first half of this proposition about a renewed economic downturn, but not the second. In fact, rather than deflation, the dollar is moving ever closer to hyperinflation.
How is deflation possible when crude oil prices have more than doubled since their post-Lehman crash low? Or more broadly, how can there be deflation when the price index of 19 commodities compiled by the Commodity Research Bureau rose 47% during this same period? It cannot of course, which means there is no deflation.
The ongoing decline in the purchasing power of the dollar has been masked by wealth destruction as over-priced assets like houses fall back to realistic levels. There is also the problem that the mainstream media broadcasts only the government calculated CPI, which is an inaccurate measure of the dollar’s eroding purchasing power.
As John Williams of www.shadowstats.com notes: “Over the decades, the BLS [Bureau of Labor Statistics] has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept.” John reports that his “SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to about 9.5%” in March from a year ago.
So the Globe & Mail article is wrong about deflation, but I am not drawing attention to it just because I agree that “the economy remains vulnerable to the feared double-dip downturn”. Instead, this article unintentionally offers compelling evidence that the dollar is approaching hyperinflation.
The so-called “shrinking” money supply that arises when adjusting for the loss of purchasing power from inflation is a characteristic portending imminent hyperinflation. Let’s call it a ‘Havenstein moment’, named after the ill-fated president of the Reichsbank who presided over the destructive hyperinflation that devastated Weimar Germany.
I first explained this phenomenon in September 2007 and questioned then whether the dollar would eventually hyperinflate because Ben Bernanke would follow the footsteps of Herr Havenstein. I quoted an insightful section from Murray Rothbard’s excellent book, The Mystery of Banking, that explicitly explains the consequences of the inflation-adjusted money supply. Here is the relevant part of that quote:
“When prices are going up faster than the money supply, the people begin to experience a severe shortage of money, for they now face a shortage of cash balances relative to the much higher price levels. Total cash balances are no longer sufficient to carry transactions at the higher price.”
As the Globe & Mail observes, these circumstances prevail today. Prices of goods and services are rising, but as it warns, the quantity of dollars in circulation is “shrinking, after taking into account inflation.” This “shortage of money” is being widely misinterpreted as deflation, which is exactly what happened in Weimar Germany shortly before the Reichsmark was swooped up in its hyperinflationary whirlwind.
Rothbard provides his usual brilliant insight to explain what happens once the “Havenstein moment’ is reached. There are two alternatives.
“If the government tightens its own belt and stops printing (or otherwise creating) new money, then inflationary expectations will eventually be reversed, and prices will fall once more – thus relieving the money shortage by lowering prices. But if government follows its own inherent inclination to counterfeit and appeases the clamor by printing more money so as to allow the public’s cash balances to ‘catch up’ to prices, then the country is off to the races. Money and prices will follow each other upward in an ever-accelerating spiral, until finally prices ‘run away’…[i.e., hyperinflate]”
Weimar Germany took the second alternative.
The dollar has now reached its ‘Havenstein moment’. Will policymakers follow the prudent advice of Murray Rothbard and ‘tighten its belt’? Or like Herr Havenstein, will Mr. Bernanke continue to ‘print’?
No need to ponder these two alternatives. The Federal Reserve must ‘print’, for one reason. Despite the noble goals assigned to it in textbooks and offered in Congressional hearings, the Federal Reserve exists for only one reason – to make sure the federal government gets all the dollars it wants to spend, which consequently has put the dollar on a hyperinflationary course.
Spending by the federal government is out of control, causing it to borrow record amounts. The money to fund this growing mountain of debt must come from savings or ‘printing’, and the sad fact is that there is not enough accumulated savings in the known universe to satisfy the spending aspirations of Washington’s politicians. So beyond what it can collect from taxpayers and extract from the world’s savings pool, the dollars the federal government is spending can only come from one place – the ‘printing press’, which in the prevailing monetary system means bookkeeping entries of the Federal Reserve.
This process of creating new dollars ‘out of thin air’ creates the hyperinflation, which the ‘Havenstein moment’ indicates is near. Sadly, like Weimar Germany, few people are prepared for this impending destruction of the dollar, but the remedy is simple – as much as practical, avoid the dollar. Own physical gold and physical silver instead.
Thursday, January 7, 2010
Byron Wien's 10 Surprises for 2010
by: Prieur du Plessis January 05, 2010
Ex-morgan stanley analyst, Byron Wien again published his annual list of surprises to expect in 2010. Wien, Vice Chairman of Blackstone Advisory Services and one of Wall Street’s best known veterans, has been publishing his list of economic, market and political surprises since 1986.
Reviewing Wien’s 2009 list, he was very accurate with the direction of most of his predictions.
He foresaw a second-half recovery in the US economy, and the S&P 500 Index rising to 1,200 (up from 903 at the end of 2008 to 1,115 by December 31, 2009). He also predicted:
The ten-year US Treasury yield climbs to 4% [up from 2.24% to 3.84%]. Later in the year, as the economy shows signs of recovery, economists and investors shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change.
Spot on.
Wien also expected the gold and oil prices to climb to $1,200 and $80 respectively - a feat accomplished in December.
He believes his ten surprises have at least a 50% chance of occurring at some point during the year. Although this is not a very high probability, his predictions nevertheless make for stimulating reading. His list for 2010 follows below.
1. The United States economy grows at a stronger than expected 5% real rate during the year and the unemployment level drops below 9%. Exports, inventory building and technology spending lead the way. Standard and Poor’s 500 operating earnings come in above $80.
2. The Federal Reserve decides the economy is strong enough for them to move away from zero interest rate policy. In a series of successive hikes beginning in the second quarter the Federal funds rate reaches 2% by year-end.
3. Heavy borrowing by the U.S. Treasury and some reluctance by foreign central banks to keep buying notes and bonds drives the yield on the 10-year Treasury above 5.5%. Banks loan more to corporations and individuals and pull away from the carry trade, thereby reducing demand for Treasuries. Obama says, "the suits are finally listening."
4. In a roller coaster year the Standard and Poor’s 500 rallies to 1,300 in the first half and then runs out of steam and declines to 1,000, ending where it started at 1115.10. Even though the economy is strong and earnings exceed expectations, rising interest rates and full valuations present a problem. Concern about longer term growth and obligations to reduce leverage at both the public and private level unsettle investors.
5. Because it is significantly undervalued on a purchasing power parity basis, the dollar rallies against the yen and the euro. It exceeds 100 on the yen and the euro drops below $1.30 as the long slide of the greenback is interrupted. Longer term prospects remain uncertain.
6. Japan stands out as the best performing major industrialized market in the world as its currency weakens and its exports improve. Investors focus on the attractive valuations of dozens of medium sized companies in a market selling at one quarter of its 1989 high. The Nikkei 225 rises above 12,000.
7. Believing he must be a leader in climate control initiatives, President Obama endorses legislation favorable for nuclear power development. Arguing that going nuclear is essential for the environment, will create jobs and reduce costs, Congress passes bills providing loans and subsidies for new plants, the first since 1979. Coal accounts for about 50% of electrical power generation, and Obama wants to reduce that to 25% by 2020.
8. The improvement in the U.S. economy energizes the Obama administration. The White House undergoes some reorganization and regains its momentum. In the November Congressional election the Democrats only lose 20 seats, much less than expected.
9. When it finally passes, financial service legislation, like the health care bill, proves to be softer on the industry than originally feared. There is greater consumer protection, more transparency, tighter restriction of leverage and increased scrutiny of derivatives, but the regulatory changes for investment bankers and hedge funds are not onerous. Trading volume and merger activity increases; financial service stocks become exceptional performers in the U.S. market.
10. Civil unrest in Iran reaches a crescendo.
Ex-morgan stanley analyst, Byron Wien again published his annual list of surprises to expect in 2010. Wien, Vice Chairman of Blackstone Advisory Services and one of Wall Street’s best known veterans, has been publishing his list of economic, market and political surprises since 1986.
Reviewing Wien’s 2009 list, he was very accurate with the direction of most of his predictions.
He foresaw a second-half recovery in the US economy, and the S&P 500 Index rising to 1,200 (up from 903 at the end of 2008 to 1,115 by December 31, 2009). He also predicted:
The ten-year US Treasury yield climbs to 4% [up from 2.24% to 3.84%]. Later in the year, as the economy shows signs of recovery, economists and investors shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change.
Spot on.
Wien also expected the gold and oil prices to climb to $1,200 and $80 respectively - a feat accomplished in December.
He believes his ten surprises have at least a 50% chance of occurring at some point during the year. Although this is not a very high probability, his predictions nevertheless make for stimulating reading. His list for 2010 follows below.
1. The United States economy grows at a stronger than expected 5% real rate during the year and the unemployment level drops below 9%. Exports, inventory building and technology spending lead the way. Standard and Poor’s 500 operating earnings come in above $80.
2. The Federal Reserve decides the economy is strong enough for them to move away from zero interest rate policy. In a series of successive hikes beginning in the second quarter the Federal funds rate reaches 2% by year-end.
3. Heavy borrowing by the U.S. Treasury and some reluctance by foreign central banks to keep buying notes and bonds drives the yield on the 10-year Treasury above 5.5%. Banks loan more to corporations and individuals and pull away from the carry trade, thereby reducing demand for Treasuries. Obama says, "the suits are finally listening."
4. In a roller coaster year the Standard and Poor’s 500 rallies to 1,300 in the first half and then runs out of steam and declines to 1,000, ending where it started at 1115.10. Even though the economy is strong and earnings exceed expectations, rising interest rates and full valuations present a problem. Concern about longer term growth and obligations to reduce leverage at both the public and private level unsettle investors.
5. Because it is significantly undervalued on a purchasing power parity basis, the dollar rallies against the yen and the euro. It exceeds 100 on the yen and the euro drops below $1.30 as the long slide of the greenback is interrupted. Longer term prospects remain uncertain.
6. Japan stands out as the best performing major industrialized market in the world as its currency weakens and its exports improve. Investors focus on the attractive valuations of dozens of medium sized companies in a market selling at one quarter of its 1989 high. The Nikkei 225 rises above 12,000.
7. Believing he must be a leader in climate control initiatives, President Obama endorses legislation favorable for nuclear power development. Arguing that going nuclear is essential for the environment, will create jobs and reduce costs, Congress passes bills providing loans and subsidies for new plants, the first since 1979. Coal accounts for about 50% of electrical power generation, and Obama wants to reduce that to 25% by 2020.
8. The improvement in the U.S. economy energizes the Obama administration. The White House undergoes some reorganization and regains its momentum. In the November Congressional election the Democrats only lose 20 seats, much less than expected.
9. When it finally passes, financial service legislation, like the health care bill, proves to be softer on the industry than originally feared. There is greater consumer protection, more transparency, tighter restriction of leverage and increased scrutiny of derivatives, but the regulatory changes for investment bankers and hedge funds are not onerous. Trading volume and merger activity increases; financial service stocks become exceptional performers in the U.S. market.
10. Civil unrest in Iran reaches a crescendo.
Thursday, December 3, 2009
China: Heart of the dragon
This article is from Roubini.com:
China’s economic growth model was a contributing factor in the current Global Financial Crisis ("GFC").
Under Deng Xiaoping, leader of the Communist Party from 1978, China undertook Gaige Kaifang (Reforms and Openness) - reform of domestic, social, political and economic policy. Economic stagnation and serious social and institutional woes that could be traced to Mao’s Cultural Revolution forced the change.
The centrepiece was economic reforms that combined socialism with elements of the market economy. It entailed engagement with the global economy reversing the traditional policy of economic self-reliance and a lack of interest in trade. As Robert Hart, 19th Century British trade commissioner for China, wrote: "[The] Chinese have the best food in the world, rice; the best drink, tea; and the best clothing, cotton, silk, fur. Possessing these staples and their innumerable native adjuncts, they do not need to buy a penny’s worth elsewhere."
In embracing markets, Deng famously observed that: "It doesn’t matter if a cat is black or white, so long as it catches mice." Deng also embraced a change in philosophy: "Poverty is not socialism. To be rich is glorious."
China’s economic reforms coincided with the ‘Great Moderation’ – a period of strong growth in the global economy based on low interest rates, low oil prices and deregulation of key industries such as banking and telecommunications. The boom was also based on increases in global trade and investment driven, in part, by the fall of the Berlin Wall, the collapse of the Soviet Union and integration of socialist economies into the world economy.
China’s growth model, inspired by the post-War recovery of Japan, used trade to accelerate the growth and modernisation of its economy. The economic engine was export driven growth. Special Economic Zones ("SEZ"), for example in Shenzen located strategically close to Hong Kong, were established to encourage investment and industry.
The model took advantage of China’s large, cheap labour force. The strategy benefited from rising costs in neighbouring Asian countries such as Japan, South Korea, Taiwan, Hong Kong and Singapore. China was able to attract significant foreign investment, technology and management and trading skills from countries keen to outsource manufacturing to lower cost locations to improve declining competitiveness.
China converted itself, at least parts of the country, into the world’s factory of choice. It imported resources and parts that were then assembled or processed and then shipped out again. The Great Moderation ensured a growing market for exports.
Innate conservatism, the desire to maintain Communist Party control of the domestic economy and avoid social disruption favoured partial market liberalisation. China’s need to provide employment for its underemployed population and improve its technology also favoured this strategy. China currently needs to grow at around 7-8% pa. to absorb workers entering the formal workforce each year.
The strategy was decidedly ‘trickle down economics’ as Deng himself acknowledged: "Let some people get rich first." Later, Deng would grouse: "Young leading cadres have risen up by helicopter. They should really rise step by step."
As economic momentum increased, foreign businesses invested in China to take advantage of the growth and rising living standards. Opportunities encouraged Chinese nationals living, studying and working overseas to return. As Deng astutely noted: "When our thousands of Chinese students abroad return home, you will see how China will transform itself."
Over time, a novel liquidity system also accelerated growth to staggering levels.
Liquidity Vortex
Export success created large foreign reserves that now total over $2 trillion. These reserves became the centre of a gigantic lending scheme where China would finance and thereby boost global trade flows.
Dollars received from exports and foreign investment have to be exchanged into Renminbi.
In order to maintain the competitiveness of its exporters, China invests the foreign currency overseas to mitigate upward pressure on the Renmimbi.
As reserves grew paralleling its growing trade surplus, China invested heavily in dollars helping to finance America’s large trade and budget deficits. It is estimated that China has invested around 60-70% of its $2 trillion reserves in dollar denominated investments, primarily U.S. Treasury bonds and other high quality securities.
Chinese funds helped keep American interest rates low encouraging increasing levels of borrowing, especially among consumers. The increased debt fuelled further consumption and housing and stock market bubbles that enabled consumers to decrease savings as the ‘paper’ value of investments rose sharply. The consumption fed increased imports from China creating further outflows of dollars via the growing trade deficit. The overvalued dollar and an undervalued Renminbi exacerbated excess U.S. demand for imported goods.
In effect, China was lending the funds used to purchase its goods. China never got paid, at least until the loan to America was paid off.
The Asian crisis of 1997-98 encouraged China to build even larger surpluses. Reserves were seen as protection against the destabilising volatility of short-term foreign capital flows that had almost destroyed many Asian countries during the crisis.
The substantial build-up of foreign reserves in China and the central banks of other emerging countries was a liquidity creation scheme. The arrangements boosted growth and prosperity in China, other emerging markets and the developed world. Commodity exporters, such as Australia, benefited significantly from the increased demand for commodity and the higher prices for resources.
In 2007, unsustainable levels of debt in many economies triggered a near collapse of the global banking system that, in turn, triggered a major slowdown in growth.
The unprecedented external demand shock, with sharp decreases in consumption and investment from synchronous deep recessions in the developed world, affected the Chinese economy. The sudden and precipitous fall in exports led to a significant slow down in China’s stellar growth rates in 2008 triggering sharp declines in stock and property markets.
Job losses in export-intensive Guangdong province were in excess of 20 million migrant workers. Workers and students entering the workforce were unable to find work. Fearful of social instability, the Beijing government moved quickly to restore rapid growth.
Panicked government spending and loose monetary policies increasing available credit is currently driving China’s recovery, contributing around 75% of China’s growth of around 8-9% in 2009. In the June quarter, Chinese exports (around 35-40% of the economy) decreased by around 20% implying that the non-export part of the economy grew strongly.
In the first half of 2009, new loans totalled over $1 trillion. This compares to total loans for the full 2008 year of around $600 billion. Current lending is running at around three times 2008 levels and at a staggering 25% of China’s GDP.
The availability of credit is fuelling rampant speculation in stocks, property and commodities. Estimates suggest that around 20-30% of new bank lending is finding it way into the stock market, driving up values. The market for initial public offerings for new companies has recommenced after being closed for six months.
China’s recovery, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. In recent parliamentary testimony, Reserve Bank of Australia Assistant Governor Philip Lowe highlighted the extent to which Australia, a major trading partner of China, was reliant on Chinese demand. Lowe noted that 23% of Australia’s total exports went to China in the most recent quarter, up from 4% 10 years ago. China now also takes 80% of Australia’s iron ore exports and 20% of coal exports.
While a significant part of the importation of commodities is restocking depleted inventory, abundant and low cost bank finance combined with a deep seated fear of the long term prospects of U.S. Treasury bonds and the dollar has encouraged speculative stockpiling artificially boosting demand.
Lock & Load
Government spending and bank loans has resulted in sharp increases in fixed asset investments (over 30% up on 2008). A major component is infrastructure spending which accounts for over 70% of the Chinese government’s stimulus package. In the first half of 2009, investment accounted of over 80% of growth, approximately double the 43% average contribution over the last 10 years.
Infrastructure investment is adding to production capacity in a world with sluggish demand and major over-capacity in many industries. In the absence of sufficient domestic demand, the production may be directed into exports increasing the global supply glut and creating deflationary pressures.
Progress on shifting the emphasis to domestic consumption has been disappointing. Government incentives, in the form of rebates for purchases of high value durables such as cars and white goods, has increased consumption in the short run (up 15% on 2008). But, over the last 25 years, Chinese consumption has declined from around 50% to its current levels of 37%.
The current expansion in lending also risks creating China’s own home grown banking crisis with a rise in non-performing bank loans. The problems of bad debts from loose lending are not new. In the 1990s, similar credit expansion led to an increase in bad debts. The big state-owned Chinese banks had to be substantially recapitalised and restructured at significant cost to the State in a series of steps that ended as recently as 2004. Recently regulators have brought pressure on banks to increase capital ratios to cover the rapid growth in their loan books.
Chinese bank regulators are concerned that new lending is being used to finance real estate and stock market speculation rather than productive purposes. They have moved to try to reduce speculative lending but it is likely that the central bank will resolutely maintain its moderately loose monetary policy because of uncertainties in the external and domestic environment.
On 24 August 2009, Chinese Premier Wen Jiabao was reported as saying: "China will maintain its stimulative policy stance because the economy, far from being on solid footing, is facing fresh difficulties, … Beijing would ensure a sustainable flow of credit and a ‘reasonably sufficient’ provision of liquidity to support growth… ‘We must clearly see that the foundations of the recovery are not stable, not solidified and not balanced. We cannot be blindly optimistic…Therefore, we must maintain continuity and consistency in macro economic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering.’"
The centralised control structure of the Chinese economy has allowed rapid action to be taken to avert the slowdown in growth. In July 2009, Su Ning, Vice Governor of the Chinese Central Bank People’s Bank of China observed: "… ‘the mind and action’ of all financial institutions should ‘be as one’ with the government’s goal, and financial institutions should properly handle the relationship between supporting the economy’s development and preventing financial risks." Even if execution is not in question, the appropriateness of the policy measures and the sustainability of the recovery are unclear.
There are also concerns that Chinese statistics are unreliable and frequently manipulated by officials to meet political and personal objectives. One unexplained and nagging discrepancy is the difference between reported growth figures and electricity consumption. It is difficult to reconcile falls in electricity consumption with continued robust economic growth.
Even China’s state-controlled media has become increasingly sceptical about the accuracy of statistics. In recent polls, a high percentage of the population doubted official data.
International commentators have become concerned about the quality of the economic data. Commenting on the time taken by China’s National Bureau of Statistics ("NBS") to compile growth data, Derek Scissors, from the Washington-based Heritage Foundation, wryly observed: "Despite starkly limited resources and a dynamic, complex economy, the state statistical bureau again needed only 15 days to survey the economic progress of 1.3 billion people."
The NBS recently launched a campaign - "Statistical Feelings: We have walked together – Celebrating the 60th anniversary of the founding of New China" - to increase confidence in its work. The campaign has already produced memorable slogans and poems. "I’m proud to be a brick in the statistical building of the republic." "I can rearrange the stars in the sky because I have statistics."
The problems extend to financial information as generally accepted accounting principles are not generally accepted in China. Writing in the 17 August 2009 New York Times, Mark Dixon, a mergers and acquisition advisor in China, expressed surprise that revenue and cost gymnastics were not included as an official event at the Beijing Olympics.
Bounding Mines
China’s $2 trillion foreign currency reserves, a large proportion denominated in dollars, may have limited value. They cannot be liquidated or mobilised without massive losses because of their sheer size. Increasingly strident Chinese rhetoric reflects rising concern about the security of these dollar investments as the U.S. issues massive amounts of debt reducing the value of Treasury bonds and the currency.
China’s Premier Wen Jiabao has expressed concern: "If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…" In December 2008, Wang Qishan, a Chinese vice-premier, noted: "We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US."
Yu Yindong, a former adviser to the Chinese central bank castigated the U.S. over its "reckless policies". He asked Timothy Geithner, the U.S. Treasury Secretary to "show us some arithmetic." At the University of Beijing, Mr. Geithner obliged indicating that the U.S. intended to reduce its budget deficit to 3% of GDP from its current level of 12% eliciting sceptical laughter from students.
China’s position is similar to that of a bank or investor with poor quality assets. China is trying to switch its reserves into real assets – commodities or resource producers where foreign countries will allow.
In the meantime, China continues to purchase more dollars and U.S. Treasury bonds to preserve the value of existing holdings in a surreal logic. On the other side, the U.S. continues to seek to preserve the status of the dollar as the sole reserve currency in order to enable the Treasury to finance America’s budget and trade deficit.
Every lender knows Keynes’ famous observation: "If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours." Almost 40 years ago, John Connally, then the U.S. Treasury Secretary, accurately identified China’s problem: "it may be our currency, but it’s your problem."
The Chinese used to refer to dollars affectionately as mei jin, literally "American gold". Chinese investments may not be the real thing – merely iron pyrite, fool’s gold.
China’s position is like that of an unfortunate who has stepped on a type of anti-personnel mine, known as a ‘bounding mine’. The mine does not explode when you step on it. Instead, it trips when you step off it as a small charge propels the body of the mine into the air where the explosive charge bursts and sprays fragmentation at a height of around 3 to 4 feet (1 to 1.3 metres). China, in building and investing its massive foreign exchange reserves in dollars and U.S. Treasury Bonds, has stepped onto the mine and it cannot step off without serious damage!
China’s economic growth model was a contributing factor in the current Global Financial Crisis ("GFC").
Under Deng Xiaoping, leader of the Communist Party from 1978, China undertook Gaige Kaifang (Reforms and Openness) - reform of domestic, social, political and economic policy. Economic stagnation and serious social and institutional woes that could be traced to Mao’s Cultural Revolution forced the change.
The centrepiece was economic reforms that combined socialism with elements of the market economy. It entailed engagement with the global economy reversing the traditional policy of economic self-reliance and a lack of interest in trade. As Robert Hart, 19th Century British trade commissioner for China, wrote: "[The] Chinese have the best food in the world, rice; the best drink, tea; and the best clothing, cotton, silk, fur. Possessing these staples and their innumerable native adjuncts, they do not need to buy a penny’s worth elsewhere."
In embracing markets, Deng famously observed that: "It doesn’t matter if a cat is black or white, so long as it catches mice." Deng also embraced a change in philosophy: "Poverty is not socialism. To be rich is glorious."
China’s economic reforms coincided with the ‘Great Moderation’ – a period of strong growth in the global economy based on low interest rates, low oil prices and deregulation of key industries such as banking and telecommunications. The boom was also based on increases in global trade and investment driven, in part, by the fall of the Berlin Wall, the collapse of the Soviet Union and integration of socialist economies into the world economy.
China’s growth model, inspired by the post-War recovery of Japan, used trade to accelerate the growth and modernisation of its economy. The economic engine was export driven growth. Special Economic Zones ("SEZ"), for example in Shenzen located strategically close to Hong Kong, were established to encourage investment and industry.
The model took advantage of China’s large, cheap labour force. The strategy benefited from rising costs in neighbouring Asian countries such as Japan, South Korea, Taiwan, Hong Kong and Singapore. China was able to attract significant foreign investment, technology and management and trading skills from countries keen to outsource manufacturing to lower cost locations to improve declining competitiveness.
China converted itself, at least parts of the country, into the world’s factory of choice. It imported resources and parts that were then assembled or processed and then shipped out again. The Great Moderation ensured a growing market for exports.
Innate conservatism, the desire to maintain Communist Party control of the domestic economy and avoid social disruption favoured partial market liberalisation. China’s need to provide employment for its underemployed population and improve its technology also favoured this strategy. China currently needs to grow at around 7-8% pa. to absorb workers entering the formal workforce each year.
The strategy was decidedly ‘trickle down economics’ as Deng himself acknowledged: "Let some people get rich first." Later, Deng would grouse: "Young leading cadres have risen up by helicopter. They should really rise step by step."
As economic momentum increased, foreign businesses invested in China to take advantage of the growth and rising living standards. Opportunities encouraged Chinese nationals living, studying and working overseas to return. As Deng astutely noted: "When our thousands of Chinese students abroad return home, you will see how China will transform itself."
Over time, a novel liquidity system also accelerated growth to staggering levels.
Liquidity Vortex
Export success created large foreign reserves that now total over $2 trillion. These reserves became the centre of a gigantic lending scheme where China would finance and thereby boost global trade flows.
Dollars received from exports and foreign investment have to be exchanged into Renminbi.
In order to maintain the competitiveness of its exporters, China invests the foreign currency overseas to mitigate upward pressure on the Renmimbi.
As reserves grew paralleling its growing trade surplus, China invested heavily in dollars helping to finance America’s large trade and budget deficits. It is estimated that China has invested around 60-70% of its $2 trillion reserves in dollar denominated investments, primarily U.S. Treasury bonds and other high quality securities.
Chinese funds helped keep American interest rates low encouraging increasing levels of borrowing, especially among consumers. The increased debt fuelled further consumption and housing and stock market bubbles that enabled consumers to decrease savings as the ‘paper’ value of investments rose sharply. The consumption fed increased imports from China creating further outflows of dollars via the growing trade deficit. The overvalued dollar and an undervalued Renminbi exacerbated excess U.S. demand for imported goods.
In effect, China was lending the funds used to purchase its goods. China never got paid, at least until the loan to America was paid off.
The Asian crisis of 1997-98 encouraged China to build even larger surpluses. Reserves were seen as protection against the destabilising volatility of short-term foreign capital flows that had almost destroyed many Asian countries during the crisis.
The substantial build-up of foreign reserves in China and the central banks of other emerging countries was a liquidity creation scheme. The arrangements boosted growth and prosperity in China, other emerging markets and the developed world. Commodity exporters, such as Australia, benefited significantly from the increased demand for commodity and the higher prices for resources.
In 2007, unsustainable levels of debt in many economies triggered a near collapse of the global banking system that, in turn, triggered a major slowdown in growth.
The unprecedented external demand shock, with sharp decreases in consumption and investment from synchronous deep recessions in the developed world, affected the Chinese economy. The sudden and precipitous fall in exports led to a significant slow down in China’s stellar growth rates in 2008 triggering sharp declines in stock and property markets.
Job losses in export-intensive Guangdong province were in excess of 20 million migrant workers. Workers and students entering the workforce were unable to find work. Fearful of social instability, the Beijing government moved quickly to restore rapid growth.
Panicked government spending and loose monetary policies increasing available credit is currently driving China’s recovery, contributing around 75% of China’s growth of around 8-9% in 2009. In the June quarter, Chinese exports (around 35-40% of the economy) decreased by around 20% implying that the non-export part of the economy grew strongly.
In the first half of 2009, new loans totalled over $1 trillion. This compares to total loans for the full 2008 year of around $600 billion. Current lending is running at around three times 2008 levels and at a staggering 25% of China’s GDP.
The availability of credit is fuelling rampant speculation in stocks, property and commodities. Estimates suggest that around 20-30% of new bank lending is finding it way into the stock market, driving up values. The market for initial public offerings for new companies has recommenced after being closed for six months.
China’s recovery, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. In recent parliamentary testimony, Reserve Bank of Australia Assistant Governor Philip Lowe highlighted the extent to which Australia, a major trading partner of China, was reliant on Chinese demand. Lowe noted that 23% of Australia’s total exports went to China in the most recent quarter, up from 4% 10 years ago. China now also takes 80% of Australia’s iron ore exports and 20% of coal exports.
While a significant part of the importation of commodities is restocking depleted inventory, abundant and low cost bank finance combined with a deep seated fear of the long term prospects of U.S. Treasury bonds and the dollar has encouraged speculative stockpiling artificially boosting demand.
Lock & Load
Government spending and bank loans has resulted in sharp increases in fixed asset investments (over 30% up on 2008). A major component is infrastructure spending which accounts for over 70% of the Chinese government’s stimulus package. In the first half of 2009, investment accounted of over 80% of growth, approximately double the 43% average contribution over the last 10 years.
Infrastructure investment is adding to production capacity in a world with sluggish demand and major over-capacity in many industries. In the absence of sufficient domestic demand, the production may be directed into exports increasing the global supply glut and creating deflationary pressures.
Progress on shifting the emphasis to domestic consumption has been disappointing. Government incentives, in the form of rebates for purchases of high value durables such as cars and white goods, has increased consumption in the short run (up 15% on 2008). But, over the last 25 years, Chinese consumption has declined from around 50% to its current levels of 37%.
The current expansion in lending also risks creating China’s own home grown banking crisis with a rise in non-performing bank loans. The problems of bad debts from loose lending are not new. In the 1990s, similar credit expansion led to an increase in bad debts. The big state-owned Chinese banks had to be substantially recapitalised and restructured at significant cost to the State in a series of steps that ended as recently as 2004. Recently regulators have brought pressure on banks to increase capital ratios to cover the rapid growth in their loan books.
Chinese bank regulators are concerned that new lending is being used to finance real estate and stock market speculation rather than productive purposes. They have moved to try to reduce speculative lending but it is likely that the central bank will resolutely maintain its moderately loose monetary policy because of uncertainties in the external and domestic environment.
On 24 August 2009, Chinese Premier Wen Jiabao was reported as saying: "China will maintain its stimulative policy stance because the economy, far from being on solid footing, is facing fresh difficulties, … Beijing would ensure a sustainable flow of credit and a ‘reasonably sufficient’ provision of liquidity to support growth… ‘We must clearly see that the foundations of the recovery are not stable, not solidified and not balanced. We cannot be blindly optimistic…Therefore, we must maintain continuity and consistency in macro economic policies, and maintaining stable and quite fast economic growth remains our top priority. This means we cannot afford the slightest relaxation or wavering.’"
The centralised control structure of the Chinese economy has allowed rapid action to be taken to avert the slowdown in growth. In July 2009, Su Ning, Vice Governor of the Chinese Central Bank People’s Bank of China observed: "… ‘the mind and action’ of all financial institutions should ‘be as one’ with the government’s goal, and financial institutions should properly handle the relationship between supporting the economy’s development and preventing financial risks." Even if execution is not in question, the appropriateness of the policy measures and the sustainability of the recovery are unclear.
There are also concerns that Chinese statistics are unreliable and frequently manipulated by officials to meet political and personal objectives. One unexplained and nagging discrepancy is the difference between reported growth figures and electricity consumption. It is difficult to reconcile falls in electricity consumption with continued robust economic growth.
Even China’s state-controlled media has become increasingly sceptical about the accuracy of statistics. In recent polls, a high percentage of the population doubted official data.
International commentators have become concerned about the quality of the economic data. Commenting on the time taken by China’s National Bureau of Statistics ("NBS") to compile growth data, Derek Scissors, from the Washington-based Heritage Foundation, wryly observed: "Despite starkly limited resources and a dynamic, complex economy, the state statistical bureau again needed only 15 days to survey the economic progress of 1.3 billion people."
The NBS recently launched a campaign - "Statistical Feelings: We have walked together – Celebrating the 60th anniversary of the founding of New China" - to increase confidence in its work. The campaign has already produced memorable slogans and poems. "I’m proud to be a brick in the statistical building of the republic." "I can rearrange the stars in the sky because I have statistics."
The problems extend to financial information as generally accepted accounting principles are not generally accepted in China. Writing in the 17 August 2009 New York Times, Mark Dixon, a mergers and acquisition advisor in China, expressed surprise that revenue and cost gymnastics were not included as an official event at the Beijing Olympics.
Bounding Mines
China’s $2 trillion foreign currency reserves, a large proportion denominated in dollars, may have limited value. They cannot be liquidated or mobilised without massive losses because of their sheer size. Increasingly strident Chinese rhetoric reflects rising concern about the security of these dollar investments as the U.S. issues massive amounts of debt reducing the value of Treasury bonds and the currency.
China’s Premier Wen Jiabao has expressed concern: "If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…" In December 2008, Wang Qishan, a Chinese vice-premier, noted: "We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US."
Yu Yindong, a former adviser to the Chinese central bank castigated the U.S. over its "reckless policies". He asked Timothy Geithner, the U.S. Treasury Secretary to "show us some arithmetic." At the University of Beijing, Mr. Geithner obliged indicating that the U.S. intended to reduce its budget deficit to 3% of GDP from its current level of 12% eliciting sceptical laughter from students.
China’s position is similar to that of a bank or investor with poor quality assets. China is trying to switch its reserves into real assets – commodities or resource producers where foreign countries will allow.
In the meantime, China continues to purchase more dollars and U.S. Treasury bonds to preserve the value of existing holdings in a surreal logic. On the other side, the U.S. continues to seek to preserve the status of the dollar as the sole reserve currency in order to enable the Treasury to finance America’s budget and trade deficit.
Every lender knows Keynes’ famous observation: "If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours." Almost 40 years ago, John Connally, then the U.S. Treasury Secretary, accurately identified China’s problem: "it may be our currency, but it’s your problem."
The Chinese used to refer to dollars affectionately as mei jin, literally "American gold". Chinese investments may not be the real thing – merely iron pyrite, fool’s gold.
China’s position is like that of an unfortunate who has stepped on a type of anti-personnel mine, known as a ‘bounding mine’. The mine does not explode when you step on it. Instead, it trips when you step off it as a small charge propels the body of the mine into the air where the explosive charge bursts and sprays fragmentation at a height of around 3 to 4 feet (1 to 1.3 metres). China, in building and investing its massive foreign exchange reserves in dollars and U.S. Treasury Bonds, has stepped onto the mine and it cannot step off without serious damage!
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